Difference Between Accounting Profit vs Economic Profit
The accounting profit can be described as the profit that is earned and reported on the income statement. The economic profit is defined as the profit that the business derives over and above the opportunity costs. The accounting profit can be found at the bottom line of income statement whereas economic profit has to be determined by determining the free cashflows.
The accounting profit can be defined as the profit that the business earns as per the book of accounts of the business. The accounting profit is determined as the difference of total sales generated by the business and the costs incurred by the business that could be accounted explicitly. The explicit costs may comprise of cost of goods sold, operational expenses and non-cash expense.
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The revenues or sales are generally income that the business generates while performing business activities. The economic profit on the other hand is determined by taking the difference of revenues generated by the business and the sum of implicit and explicit costs generated by the business. The implicit costs are generally regarded to the opportunity costs that the business has to bear for foregoing an opportunity by selecting an alternative through the course of business. The business generally has access to the alternatives at hand basis which selection of any one of them results in commitment of organizational resources and the business cannot back track on their decisions as they would had exercised their choice or option of selecting the best alternative or course of action from the available choices at hand.
Head to Head Comparison between Accounting Profit vs Economic Profit (Infographics)
Below are the top 5 differences between Accounting Profit vs Economic Profit:
Key Differences between Accounting Profit vs Economic Profit
Following are the key differences between Accounting Profit vs Economic Profit:
- The accounting profit can be termed as the profit that the business realizes for a given financial year. Economic profit on the other hand defines as the profit levels that the business earns over and above the expenses that are generally termed as opportunity costs.
- The accounting profit is generally larger than the economic profit as economic profit is determined using multiple assumptions along with the re-use of multiple categories of income and expenses.
- The accounting profit is determined by deducting expenses arising from assets being leased, depreciation or non-cash expense, provisions for the development costs whereas the economic profit may comprise of opportunity costs, salvage or residual values, charges on inflation, taxation rates, and interest levied or applied on cashflows.
- The accounting profit can be defined as the revenue that is earned post deducting all costs of economic nature. The economic profit is achieved the revenues are earned over and above opportunity costs. The accountant generally relies on the accounting profit as it accounts for production costs and their overall impact on the earning potential.
- The economist always relies on the economic profit as it tells the economist how the business utilized their resources and assessed the opportunity costs to earn a positive economic profit. The business generally incorporates a vision to earn a higher economic profit. The economic profit is generally positive when the accounting profits are over and above the overall implicit costs.
- The business if has accounting profit to be below implicit costs then the business tends to earn a negative economic profit. If the business earns negative economic profits, it is generally recommended that the business divest itself.
- It is to be noted that the equilibrium is achieved for the economic profit if the business implicit costs are equivalent to the explicit costs wherein both debtholders and equity holders earn their required rate of return.
Accounting Profit vs Economic Profit Comparison Table
Let us look at the comparison table of Accounting Profit vs Economic Profit.
Economic ProfitThe accounting profit is a metric that is of importance to the accountant.Economic profit is a metric that is of importance to the economist.The accounting profit is defined in terms of net income that the business generates or earns through the course of the accounting or financial year.The economic profit is defined as the surplus that remains with the business after total opportunity costs are deducted from the revenues earned.The accounting profit is regarded as relevant in terms of accounts and financial perspective.The economic profits are derived from certain assumptions and estimations and generally cannot be regarded as relevant as the metric is just a precision.The accounting profits reflect the true profitability of the business in accounting terms.Economic profit indicates the efficiency level of the business in terms of how they utilize their resources to drive maximum value generation.The accounting profit is determined as the difference in total sales or revenues generated by the business with the explicit costs.The economic profit is determined as the difference between the total revenue or sales generated by the business and the sum of explicit costs and implicit costs.
It is to be noted that the opportunity costs can never be negative as a general principle of economics and hence the economic profit has to exceed the accounting profit so that the opportunity costs tend to be positive. The reason as to why opportunity costs cannot be negative is that the business may not choose to act on the opportunities that they have on hand making them either avoid an opportunity to earn as well as to bear expenses.
A business would tend to exist only when the business is to generate economic profit that is more than accounting profit and it indicates the profit earnings capability of the business even in the near future as well as how they have performed in the past. For the shareholders, the accounting profit is regarded of the utmost importance as it presents a true picture of financial performance and generally, investors are not that much learned to compute economic profits by themselves. The economic profit is generally determined by economists and internal stakeholders to perform internal analysis by assuming assumptions and taking all opportunity costs into account as they are pursuing or chose to pursue certain activities. Economic profit can deliver approximation as to which desired direction the business has headed to.
This is a guide to Accounting Profit vs Economic Profit. Here we also discuss the Accounting Profit vs Economic Profit key differences with infographics and a comparison table. You may also have a look at the following articles to learn more
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